For many years, all closed-end funds (CEFs) were structured as perpetual funds, meaning they have no “maturity” or termination date. The introduction of CEFs with defined terminations — term and target term funds — has created additional opportunities for investors.
All closed-end funds (CEFs), regardless of their structure, have some basic features in common:
- They raise investment capital by offering a fixed number of shares through an initial public offering (IPO)
- Following the IPO, fund shares trade in the open market on an exchange.
- Investors can purchase fund shares during the IPO and/or after the IPO via the exchange.
The primary differences between perpetual, term and target term funds are the options available to investors looking to exit their fund investments and what they can expect to receive.
Perpetual Funds
Because perpetual CEFs don’t have a termination date, shareholders looking to exit their investment sell their shares on the exchange at the current market price, which may be more or less than their purchase price.
Why consider a perpetual CEF?
Investors may choose a perpetual fund because they can remain invested in the fund until they decide to sell their shares. Given that the majority of CEFs today are perpetual, investors also have more choices when it comes to strategies and asset classes in which to invest.
Term funds
A term fund has a specified termination date at which time the fund’s portfolio is liquidated. Investors who own shares when the fund terminates receive a cash payment equal to the NAV per share at that time. This NAV may be higher or lower than what the investor originally paid.
Why consider a term CEF?
Investors may prefer a term CEF because they have a specific investment time horizon that aligns with the fund’s termination date and know they will receive the NAV per share at that time. Since CEF NAVs tend to be more stable and predictable than prices set in the market, a term fund’s return of NAV can provide a greater level of price certainty than selling shares in the open market.
Target term funds
Like term CEFs, target term funds have a defined termination date. However, target term CEFs seek to return a specific, predetermined amount per share to shareholders when the fund terminates, rather than whatever amount the then-current NAV represents. At Nuveen, this amount is the NAV at the time of the IPO (“original NAV”).2 Therefore, shareholders who purchased their shares at the IPO expect to receive the same NAV per share that they originally paid. Shareholders who purchased shares after the IPO should also receive the original NAV, but that may be more or less than the price they paid for their shares.
Because one of the goals of a target term CEF is to return the original NAV to shareholders, the fund’s managers will manage the portfolio to help ensure sufficient assets are available at termination to meet this objective.3 For this same reason, bond strategies are more prevalent in target term as well as term funds because bond maturities can be more easily aligned to a fund’s termination date.
Why consider a target term CEF?
The appeal of target term CEFs is two-fold: the defined life of the fund which, like term funds, enables investors to plan to future investments or expenses, and the fact that shareholders know specifically what amount per share the fund is targeting to return. For shareholders who bought on the IPO, this amount is equal to their initial principal investment.
1 Although the fund has no specified termination date, it can be terminated upon notice to shareholders.
2 The objective to return the Fund’s original NAV is not an express or implied guarantee obligation of the Fund.
3 This typically includes limiting the fund’s investment to securities with maturities near that of the fund’s termination, and may include retaining a portion of the fund’s earnings which would reduce fund distributions prior to termination.
Important risk considerations
Closed-end fund shares are subject to investment risk, including the possible loss of the entire principal amount that you invest. Common shares frequently trade at a discount to their NAV. At any point in time, your common shares may be worth less than you paid, even after considering the reinvestment of fund distributions. Closed-end fund historical distribution sources have included net investment income, realized gains, and return of capital.
FAQs
A closed-end fund is a type of mutual fund that issues a fixed number of shares through one initial public offering (IPO) to raise capital for its initial investments. Its shares can then be bought and sold on a stock exchange, but no new shares will be created, and no new money will flow into the fund.
What is the legal structure of a closed-end fund? ›
A closed-end fund is created by issuing a fixed number of common shares to investors during an initial public offering (IPO). Subsequent issuance of common shares can occur through secondary or follow-on offerings, at-the-market offerings, rights offerings, or dividend reinvestments.
How does a closed-end fund work? ›
A closed-end fund is a type of investment company that pools money from investors to buy securities. Closed-end funds are similar to mutual funds in that they professionally manage portfolios of stocks, bonds or other investments (including illiquid securities).
What is the term structure of a closed-end fund? ›
A term fund has a specified termination date at which time the fund's portfolio is liquidated. Investors who own shares when the fund terminates receive a cash payment equal to the NAV per share at that time. This NAV may be higher or lower than what the investor originally paid.
What is the downside to closed-end funds? ›
Investing in closed-end funds involves risk; principal loss is possible. There is no guarantee a fund's investment objective will be achieved.
What is the structure of a closed-end fund? ›
A closed-end fund is a type of mutual fund that issues a fixed number of shares through one initial public offering (IPO) to raise capital for its initial investments. Its shares can then be bought and sold on a stock exchange, but no new shares will be created, and no new money will flow into the fund.
What is the truth about closed-end funds? ›
A closed-end fund manager does not have to hold excess cash to meet redemptions. Because there is no need to raise cash quickly to meet unexpected redemptions, the capital is considered to be more stable than in open-end funds. It is a stable capital base.
What happens to closed-end funds when interest rates rise? ›
Historically, whenever short-term rates begin to rise, investors start taking a cautious view of CEFs and the funds often begin trading at discounts (or at widening discounts) to their net asset values (NAVs). Fixed income CEF strategies, in particular, are typically hardest hit in such scenarios.
What is the formula for a closed-end fund? ›
The NAV of a closed-end fund is calculated by subtracting the fund's liabilities (e.g., fund expenses) from the current market value of its assets and dividing by the total number of shares outstanding. The NAV changes as the total value of the underlying portfolio securities rises or falls.
What are the risks of CEF funds? ›
CEFs frequently trade at a discount to NAV and there is no assurance a CEF will appreciate to its NAV. Interest rate Risk – Income received from a CEF may fluctuate significantly based on changes in interest rates. As interest rates rise, bond prices usually fall, and vice versa.
Closed-end funds (“CEFs”) can play an important role in a diversified portfolio as they may offer investors the potential for generating capital growth and income through investment performance and distributions.
Who regulates closed-end funds? ›
Characteristics of Closed-End Funds
A closed-end fund is a type of investment fund or company that is registered under the Investment Company Act of 1940, subject to the requirements and limitations of such act and the rules thereunder, and regulated by the Securities and Exchange Commission.
What determines the price of a closed-end fund? ›
Like other publicly traded securities, the market price of CEF shares fluctuates and is generally determined by supply and demand in the marketplace, among other factors.
Can you withdraw from closed-end funds? ›
With a closed-end fund, an investment company sells a fixed number of shares in the fund to investors. Managers of the fund have a relatively fixed amount of capital to invest over time, because investors can't withdraw money from the fund or buy in after the IPO — They can only buy or sell shares on an exchange.
Is a closed-end fund better than an ETF? ›
The Bottom Line
CEFs, while costing more because they are mainly actively managed, can trade at a discount to their NAV. Investors looking for standard, safer investment strategies would do well choosing an ETF, whereas investors looking for alpha returns may do better with a CEF. Fidelity. "Closed-end Funds vs.
What are the highest paying closed-end funds? ›
10 Best High-Dividend Closed-End Funds (CEFs)
| Ticker | Name | 3-year Ave Annual Return % |
|---|
| CEM | ClearBridge MLP and Midstream | 53% |
| HCAP | Harvest Capital Credit | 46% |
| CEN | Center Coast Brookfield MLP & Energy Infrastructure | 45% |
| NML | Neuberger Berman MLP and Energy Income | 45% |
6 more rowsBecause funds are generally formed as Limited Partnerships, investors are often referred to as limited partners. In raising a fund, the fund founders will reach out to sources of institutional capital such as pension plans and university endowments, as well as high net worth family offices and individuals.
What is the legal entity structure of a hedge fund? ›
A typical hedge fund structure includes one entity formed as a partnership for U.S. tax purposes that acts as the Investment Manager (IM). Another entity functions as the General Partner (GP) of the Master Fund.
Do closed-end investment companies have a fixed capital structure? ›
Closed-end funds have a fixed capital structure and number of shares outstanding, hence the term "closed-end." Following an initial public offering, their shares are traded on an exchange between investors.
